Wednesday, April 21, 2010

Own the Fed — the Program, Part VI: Hitting the Pavement

There's an old joke about a man who fell off of a skyscraper. As he passed each story on the way down, people asked him how things were going. Being someone who could clearly put the best spin on the situation, he replied, "Doing all right so far." We assume that these optimistic utterances stopped when his head met the pavement.

That response pretty much describes the "cautious optimism" we see exuded by economists and policymakers regarding the current alleged recovery from the Great Recession. Grossly inflated share values, short selling, and manipulation of derivatives provided the trigger for both the Great Depression as well as today's economic downturn. In response, the whole thrust of the Federal Reserve and the federal government in union with Wall Street has been to re-inflate share values, short sell toxic mortgage-backed securities to the Federal Reserve, and manipulate derivatives.

Consequently, despite all the hype over the announced "end of the recession" in July of 2009, there has been a rapid growth in distrust of the federal government (Liz Sidoti, "Poll: 4 out of 5 American's Don't Trust Washington," Associated Press, 04/19/10), and widespread rejection (Meghan Barr, "Recession is Ending? Some Americans Don't Buy It," Associated Press, 04/19/10) of claims that the country has turned itself around (Daniel Gross, "The Comeback Country," Newsweek, 04/09/10). Apparently, mindless faith in the word of the elites, whether political, economic, or academic, isn't what it used to be. People are starting to demand substance — and they are evidently becoming convinced that the State is not the institution to deliver it. The experts and the politicians who rely on them may finally have hit the pavement.

Nor is this an unexpected development from within the framework of the Just Third Way. As we have already seen in this series, many of the assumptions used by economists and policymakers contradict "the economics of reality." (Louis Kelso, Two-Factor Theory: The Economics of Reality. New York: Random House, 1967.) With the State claiming the power to change reality ("re-edit the dictionary," as Keynes called it in his Theory of Money), to say nothing of the alleged right to control all financial transactions and determine the terms of all contracts (ibid.), common sense, to say nothing of rational self-interest, was apparently relegated to the dustbin of history long ago. That being the case, it becomes almost a holy duty — and some would delete "almost" — on the part of the economic and political elites to violate every one of the "four pillars of an economically just society," based as these pillars are on the inherent dignity of every human being:

• A limited economic role for the State,

• Free and open markets as the best means for determining just wages, just prices, and just profits,

• Restoration of the rights of private property, especially in corporate equity, and (the "fatal omission" of every major economic system in the world),

• Widespread direct ownership of the means of production, individually or in free association with others.

The institutions of society have been distorted and the barriers have been raised against the great mass of people participating in the vast network of institutions that we call the common good. This is especially true for those institutions relating to the financing of capital formation. Nor is this an unexpected development. The State's role in the economy and in everyday life has increased dramatically since the end of the American Civil War. Ironically, this accelerated with the virtual government takeover of the Federal Reserve System in the early 20th century. The Federal Reserve is an institution specifically designed to de-concentrate economic power in the private sector without recourse to State control. (U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit, February 28, 1913. Washington, DC: U.S. Government Printing Office, 1913.) The Great Depression provided the State with the leverage it needed to extend its control even further through the New Deal.

The Great Recession has provided the opportunity to complete a State takeover of virtually every aspect of human life, so that "no one can breathe against their will." (Quadragesimo Anno, 1931, § 106.) Ostensibly this has been to protect the free market and capitalism by saving companies and industries "too big to fail." This is a claim tantamount to an admission of socialism. The result has been to concentrate control over both economic and political power in a bizarre union of the federal government and an economic elite composed of experts in gambling, speculation, and manipulation of the financial markets.

Not surprisingly, this arrangement bears a striking resemblance to the situation Walter Bagehot described in The English Constitution (1867) and Lombard Street (1873), and which was philosophically aligned with the totalitarianism described by Thomas Hobbes in Leviathan (1651). As far as Hobbes and Bagehot were concerned, the State in the person of the sovereign may be the ultimate owner of everything (Leviathan, op. cit., XXIV), but the financial and commercial elite control the country (The English Constitution, Chapter II: "The Monarchy"). The situation is analogous to that described by Pope Pius XI in 1931 when he noted that wealth and power are greatly concentrated, so much so that the financial elite can be termed an "economic dictatorship." (Quadragesimo Anno, op. cit., § 105.)

The aims of a free people, and those of a financial and political elite unaccountable to anyone are necessarily different, if not inevitably at permanent loggerheads. By controlling the Federal Reserve and diverting its money creation powers from meeting the needs of the private sector, to financing government, the federal government — the political elite — has become unaccountable to the people. This is as Henry C. Adams predicted. (Henry C. Adams, Public Debts, An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, 22-23.)

By controlling the federal government and persuading the political elite (to say nothing of the incestuous relationship that has developed between the financial elite and that of the State), the "economic dictatorship" has become virtually unaccountable to anyone. This is best exemplified by the repeal of the Banking Act of 1933 ("Glass-Steagall"). Repealing Glass-Steagall substituted subjective opinion and expedience in the determination of whether ethics had been violated or even a crime committed, for the objective facts ascertainable from circumventing systemic internal controls of the financial system.

The effect was to take away the ability of the financial system to regulate itself, with the State stepping in only when individual violations occurred or the system itself needed reform that it could not handle itself. Removal of internal controls put in its stead direct State oversight and control, and the opinion of bureaucrats with extremely interested motives as to whether something was "wrong," or must be tolerated in order to maintain the current elite in its wealth and power at the expense of ostensible owners and the taxpayer.

Private property in the form of share ownership, or even the quasi- or secondary ownership of a creditor was rendered meaningless. Private property was abolished to preserve capitalism, while "freedom" is an effective nullity. As William Cobbett noted, "Freedom is not an empty sound; it is not an abstract idea; it is not a thing that nobody can feel. It means, — and it means nothing else, — the full and quiet enjoyment of your own property. If you have not this, if this be not well secured to you, you may call yourself what you will, but you are a slave. (William Cobbett, A History of the Protestant Reformation in England and Ireland, 1827, §456.)

In consequence, while many authorities today presume the increasing wealth and power gap to be of great benefit to society (John Maynard Keynes, The Economic Consequences of the Peace, 1919, 2.III), it is actually a symptom of serious social, economic, and political disorder. That is why we have seen the "American Dream" shift from owning an adequate if modest stake of productive assets — usually in the form of a farm or small shop or factory — to having a good wage system job and owning a house, to, finally, having a claim on State assistance with ownership of nothing. Nowhere is this more evident than in the recent spate of articles calling home ownership into question, highlighting the "dangers" of home ownership and extolling the condition of dependency — economic slavery (e.g., Paul R. La Monica, "Renting: The New American Dream?" CNNMoney.com, 04/15/10).

Over the past eighty years or so, home ownership has been considered the chief means by which ordinary Americans build a moderate stake of wealth. This is largely psychological, for a home does not generate a stream of income, while the gains realized from the sale of a home are usually due either to inflation or speculation. Home ownership is not a substitute for direct ownership of capital assets that generate a stream of income for the owner. Nevertheless, direct ownership of a valuable asset that can be liquidated as a last resort is infinitely preferable to a pile of rent receipts.

Even this, however, is under attack. The elites with their increasing concentration of wealth and power in fewer and fewer hands cannot seem to abide anyone else having anything. The great mass of people exists not even to serve, for human labor has been diminishing in value relative to technology for some time. Instead, "consumers" exist only to spend and (within acceptable limits) consume — and to spend by any means necessary to increase the wealth and power of the elites.

The ideal situation, of course, is for "consumers" (rarely "people") to spend without consuming, and for savers to invest without producing, an arrangement implicit in Keynesian economics. Keynes ignored production, the purpose of which is consumption, as Adam Smith pointed out in somewhat obvious fashion more than two centuries ago. Instead, Keynes concentrated on stimulating "effective demand." In the special language of economists, "effective demand" does not mean the wants and needs of people for marketable goods and services, but the ability to buy marketable goods and services — purchasing power. Whether people receive value for their purchases is irrelevant, as long as they spend.

Behind the triggers of the Great Recession as well as the Great Depression was this desire to get something for nothing. Speculation on Wall Street in the 1920s produced nothing, and yet seemed to yield tremendous profits — for a while. More recently we had the sub-prime mortgage bubble and the "collateralized debt obligations" that, combined with hedge funds, allowed investment banks joined with commercial banks and insurance companies to profit from both gains and losses. This arrangement ensured that investors would lose billions no matter what happened — to expend enormous amounts of "effective demand" without receiving any benefit in return. The "economic dictators" were able to make immense profits without having to go through the drudgery of actually having to produce a marketable good or service. (Rick Newman, "How Goldman Sachs Might Help Democrats in November," U.S. News and World Report, 04/16/10.)

The problems associated with what we can only regard as an unholy union of private and public sector elites are becoming obvious to some commentators, even in the halls of those normally dedicated to the maintenance of the new status quo. In the Wall Street Journal, Gerald P. O'Driscoll, Jr., relates the collusion of private sector interests and the State elite that has resulted in a phenomenal growth of State power, and all to support the interests of an extremely small economic dictatorship. As O'Driscoll reports,

On April 5 of this year [2010], The Wall Street Journal chronicled the revolving door between industry and regulator in "Staffer One Day, Opponent the Next."

Congressional committees overseeing industries succumb to the allure of campaign contributions, the solicitations of industry lobbyists, and the siren song of experts whose livelihood is beholden to the industry. The interests of industry and government become intertwined and it is regulation that binds those interests together. Business succeeds by getting along with politicians and regulators. And vice-versa through the revolving door.

We call that system not the free-market, but crony capitalism. It owes more to Benito Mussolini than to Adam Smith. ("An Economy of Liars," WSJ, 04/20/10, A21)

Nevertheless, a significant part of the problem is not regulation itself, but the type of regulation. The free market requires not endless lists of rules and regulations promulgated by bureaucrats and politicians with an eye toward their eventual profit, but limited State involvement directed toward establishing and maintaining a "level playing field." That necessarily means an anti-monopoly and pro-competition stance on the part of the State. The free market must structure itself, even if limited State assistance is required, not be "structured" by arbitrary and sometimes incomprehensible State action. The goal is to maintain adequate internal controls that prevent, not simply forbid, collusion between institutions and departments with incompatible functions such as investment banks, commercial banks, and insurance companies. As O'Driscoll points out in a passage that could have come straight out of a textbook on auditing,

The idea that multiplying rules and statutes can protect consumers and investors is surely one of the great intellectual failures of the 20th century. Any static rule will be circumvented or manipulated to evade its application. Better than multiplying rules, financial accounting should be governed by the traditional principle that one has an affirmative duty to present the true condition fairly and accurately — not withstanding what any rule might otherwise allow. (Ibid.)

Fair and accurate presentation of the financial position of an entity, of course, relies absolutely on a sound and effective system of internal control, as any second year accounting student can tell you. It's not enough to order the receivables clerk not to authorize or make disbursements. You must separate receivables from payables — period. There is, as O'Driscoll states, always a way to circumvent even the most strongly expressed and stern rule or regulation, even one with horrifying penalties attached. The temptation is simply too great for some people, especially in our morally ambiguous society, not to write out that check to him- or herself (or in payment of a false invoice sent from a P. O. Box owned by a fictitious company with all receipts automatically transferred from a lockbox to a numbered bank account in the Cayman Islands or Lichtenstein).

Nor is enforcing external rules the answer. From experience, this writer knows that often a company will quietly let a criminal go free rather than expose itself to the bad publicity a scandal would bring. The loss of a few hundred thousand, or even millions of dollars is nothing to the cost of the damaged image and the expense of an effective prosecution — something of which clever criminals are well aware.

Of course, eventually such slackness catches up with you. The Catholic Church, for example, is now reaping what it has sown for trying to protect itself by putting a false mercy and a very real expedience before justice and truth. This says nothing about the validity of the teachings of the Catholic Church, of course — the Church's "system." It does, however, say a great deal about the frailty and need for correction of its human agents, as Pope Benedict would be the first to admit.

The State and the financial community have no such out. Revolving door opportunists cannot claim to be protecting a divinely established, if human-maintained institution, regardless what political, social, and economic theories they may have imbibed through Sir Robert Filmer (Patriarcha, or, The Natural Power of Kings, 1680) and his disciple Hobbes. On the contrary, not only has it become painfully obvious that the economic dictators known as crony capitalists — "an economy of liars" — are running the system for their own private advantage, they have manipulated a system that started out with some serious flaws in the first place. Instead of removing barriers that inhibit or prevent people from entering the market and carrying out economic activity on a level playing field with the same (and, hopefully, minimal) rules for everyone within a system that makes sense, they have industriously erected more barriers, and invented increasingly complex and baffling "financial vehicles" to obscure what they are doing.

It is simplicity itself to restructure the system to your own advantage when you control the State and have a population that labors under the delusion that the State can do anything, even change reality. You need merely pass a law. If that doesn't work, pass more laws. If that doesn't work (and it won't), have the State take over . . . under the direction of the financial experts, of course, who can be counted on to advise their future and past associates to benefit themselves as much as possible.

Nor is any of this mess offset by the presumed "good news" of the end of the Great Recession, or (as it might be termed), the Gospel of Greed. Even the prosecution of Goldman Sachs has the air of political opportunism and lust for power rather than an action taken in respond to a demand that justice be done:

The Goldman case potentially gives the Obama administration and the Democrats running Congress a much-needed scalp — and a very rich one, at that. From a purely political perspective, Goldman is a great target: A recent Gallup poll shows that confidence in banks is near historic lows, and many Americans feel bottomless resentment toward financiers who make deals that generate lavish commissions, but don't really produce anything of value. (Newman, op. cit.)

If that were not enough, we have the spectacle of revolving door opportunists carefully preparing their defenses. Possibly in response to his reading of public opinion as well as the outrage he knew would ensue once the SEC's action against Goldman Sachs became public, Timothy Geithner earlier announced that he considered the manner in which the presumed recovery had been handled "deeply unfair." ("Geithner: Disparity in recovery 'deeply unfair'," The Washington Post, 04/01/10.) The article was essentially a "pre-excuse" in order to divert the blame when the so-called recovery turns sour — as indeed it must, as it is not backed up either by sustainable production or an increase in productive capacity in which more people can participate as owners.

Yes, business has been "growing" over the past ten months or so, but 1) it's only replacing inventory, and 2) America's industrial base, even if it reached full output, is a shadow of its former self. There are few people alive today who remember that in 1933 — generally considered the worst year of the Great Depression — industrial output was "recovering," showing gains in a number of months. Of course, the economy suffered another serious downturn three years later when the Federal Reserve raised its rates to dampen down the overheated economy because the authorities decided that the recovery was proceeding too fast.

Adding to the problem is the anticipated cost of the new health care mandate. The Obama administration appears to have failed to take into account that ordering employers to pay for workers' health care is a tremendous incentive to get rid of workers and replace them with cheaper foreign workers or more efficient (or at least cheaper and more tractable) technology. The "write down" controversy pales in comparison with the uproar that will ensue when workers find themselves priced out of the labor market.

If that were not enough, business folk as well as the speculators on Wall Street are desperately trying to predict when Federal Reserve Chairman Benjamin Bernanke is going to raise interest rates. (This may also account for the reported rise in business activity, as businesses rush to borrow now at low interest rates in anticipation of a raise in rates, hoping that they will be able to sell what they have produced.) Raising interest rates is the standard tool the Federal Reserve uses to reduce lending for speculative purposes, presumably preventing bubbles from forming. The problem is that putting on the brakes by raising all interest rates means starving the productive private sector for credit in order to inhibit or prevent speculation.

Financial institutions are then forced into an "Asset-Liability Mismatch." They seek out places to put their money that have higher (and increasingly speculative) returns in order to cover the higher cost of that money. This, in part, is what led to the savings and loan crisis of the 1980s. As that experience demonstrated, raising interest rates to inhibit or prevent speculation actually encourages speculation — and, as happened in the mid-1930s and early 1990s, precipitates an economic downturn . . . at a time when we are still in the process of trying to recover from the last one.

We might be tempted to say that the "mini-depression" of the mid-1930s and the recession of 1990-91 weren't all that bad. After all, the economy recovered, didn't it?

Yes and no. The monetary and fiscal policies of the New Deal didn't bring the country out of the downturn of the mid-1930s. World War Two did that. As for the savings and loan debacle, that directly affected only a relatively limited sub-sector of the financial markets. While the final bill was large, in the neighborhood of $160 billion, and is blamed for precipitating the recession of '90-91, most of the economy remained more or less sound, making for a relatively rapid recovery.

That is not the case today. We do not have an Adolph Hitler to start a genocidal war that requires full mobilization of all resources to give us a fighting chance to survive. Neither do we have a basically sound economy to cushion us from the failure of a relatively limited portion of the financial sector. What we do have is an economy, such as it is, from which a large measure of productive capacity has been taken away, and which the State seems intent on undermining further. Perhaps that is what Geithner sees, and why he appears to be so intent on excusing himself and trying to fix the blame elsewhere for the United States pursuing its current suicidal economic policies. He doesn't want to be strung up from a lamppost when the economy hits the pavement.

What is the solution? Obviously, we need to rebuild what Moulton termed "America's Capacity to Produce" (Washington, DC: The Brookings Institution, 1934). That, however, is not enough. We also have to rebuild "America's Capacity to Consume" (Washington, DC: The Brookings Institution, 1934). This will require a full mobilization of resources such as we have not seen since World War Two — but it can be done. Both of the goals can be accomplished at the same time by implementing Kelso and Adler's "Proposal to Free Economic Growth from the Slavery of Savings." Every man, woman, and child must be given the opportunity to produce through direct ownership of both labor and capital, thereby supporting the consumption from which the demand for capital is derived.

Consistent with Say's Law of Markets, producing in a way in which everybody participates through ownership in and of itself, not artificial State action, inflation, or direct redistribution restores consumption to the necessary sustainable level, building and maintaining a sound economy.